IMF Survey: IMF Outlines Joint Support Plan with EU for Portugal

IMF News, May 6, 2011

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Joint financing package worth €78 billion (about $116 billion).
EU pledge: €52 billion.
IMF contribution: €26 billion, to be provided over three years under the Extended Fund Facility.
Main goals: restore competitiveness, reignite growth, and create employment.
Purpose: provide breathing space to establish a strong record of policy implementation before returning to the markets.

Portugal averaged 1 percent growth during the past ten years—the slowest in the euro area.
Problems: large fiscal deficit, high levels of debt, and persistent unemployment.
Recovery expectation: "We think a recovery will get under way in the first half of 2013, provided the reforms are implemented as planned."

Fiscal adjustment size: measures amounting to about 10 percent of GDP (including those in the 2011 budget).
Deficit path: from 9.1 percent of GDP in 2010 to 3 percent of GDP by 2013.
Pace: strong and frontloaded adjustment; undertaking such an adjustment in only three years is described as "extremely ambitious by any standard."
Implementation: half of the necessary adjustment already incorporated into the approved 2011 budget; government has identified all measures needed to reach the 3 percent target.
Social protection in fiscal context:
- Low-income earners will be exempt from public sector wage cuts.
- Low-income pensioners will be exempt from a planned pension freeze.
- Enhanced means testing for all social transfers.
- Protection from a co-payment increase in healthcare for the poor.
- Reduced period needed to access unemployment insurance.

Three-pronged strategy: tackle structural problems, strengthen fiscal policy, ensure financial sector stability.
Proposed labor cost measure: sharp reduction in social security contributions in the order of 3–4 percent of GDP (offset by other tax and expenditure adjustments).
Targeted nontradable sectors for increased competition: electricity, transportation, and telecommunications.
Instruments: regulatory reform and accelerated privatization to reduce excessive profits and increase competition.
Labor market reforms: address the "dual contract" problem by aligning protections for open-ended and fixed-term hires; increase training opportunities for low skilled workers.

Assessment: Portuguese financial sector judged "fundamentally sound" but affected by government problems and reduced access to wholesale markets.
Capital adequacy goal: increase in capital adequacy ratios to 10 percent (already under way) to restore confidence and return banks to wholesale markets.
Backstops: fully funded backstop mechanisms for capital and liquidity support included in the program should some banks need help.
Stance: preference for market-based restructuring, with contingency support available.

Examples of difficult measures:
- 5 percent cut in public sector wages in 2011.
- Wages and pensions frozen until 2013.
- Civil service staff numbers reduced in both 2012 and 2013.
- Suspension of all new public-private partnerships and large infrastructure projects.
- Streamlining spending on state-owned enterprises, local and regional government, and defense.
Equity focus: measures aim to attack rent-seeking and privileges of the relatively few and well-off; design a fairer and more equitable tax system.

Priority: create new jobs, especially for the young; address high youth unemployment.
Mechanisms for job creation: competition-enhancing reforms, labor market flexibility, reducing disproportionate burdens on temporary workers.
Training: increased training opportunities for low skilled workers.

Need for broad political support and ownership for successful implementation.
Encouraging signs: discussions with main opposition parties suggest broad consensus exists.
Justification for expected success: program described as comprehensive, multi-year, credible, frontloaded, economically and socially balanced, and backed by exceptional international support.

International Monetary Fund.